Joe Biden is the projected winner of the presidential election, while control of the Senate will be won by a slim margin following runoff elections for Georgia’s two seats in January. What does a divided government mean for the middle market? RSM is looking at the policy implications and key issues for various industries. This is one in our series of industry-focused outlooks for a Biden administration.
According to Joe Biden’s plan:
The new Democratic White House hopes to usher in an extended period of greater government spending. According to an analysis by the University of Pennsylvania’s Wharton School of Business Budget Model, Biden’s policy proposals suggest $5.37 trillion of increased spending over the next 10 years (paired with increased tax revenue). Key areas of increased spending include education (e.g., Title I funding, universal pre-K, college tuition assistance), infrastructure (e.g., high-speed rail, water infrastructure, public transit) and research and development (e.g., 5G, clean energy, AI).
What a closely divided Senate means for government contractors:
A divided government will result in meaningful shifts in government spending taking longer than they would have under a blue wave scenario. Therefore, a relative status quo may continue in the short term while government contractors position themselves for long-term spending realignment.
In the short term, imposing (or lifting) regulations is a key issue for government contractors, particularly in a transition between administrations with the ability to execute and revoke executive orders relating to government procurement. President Trump issued a variety of executive orders (Nos. 13800, 13806, 13873 and 13953) that focused on shoring up national security vulnerabilities related to the defense supply chain, information technology and critical infrastructure. While the executive orders involving WeChat and TikTok garnered the most media attention, others focused on limiting foreign participation in government procurement, discouraging offshoring and supporting domestic control of the defense supply chain. The Biden-Harris platform acknowledges such national security vulnerabilities (particularly those China could be in position to exploit), suggesting similar initiatives may continue to some extent.
One pertinent supply chain security issue for contractors relates to compliance with section 889(a)(1)(B) of the National Defense Authorization Act, made effective Aug. 13, 2020. This interim rule seeks to prohibit the federal government from extending or renewing contracts with an entity that “uses any equipment, system, or service that uses covered telecommunications equipment or services as a substantial or essential component of any system, or as critical technology as part of any system.” (More specifically, this refers to equipment produced by certain Chinese entities deemed a threat to national security, such as Huawei Technologies Company and ZTE Corporation.)
In other words, contractors were tasked with scrubbing their supply chains and business operations to identify and remove all traces of companies deemed national security threats. Contractors scrambled to comply with the interim rule by August, and they remain ready to respond to additional clarification and compliance requirements, given the heavy burden associated with full compliance. Although section 889’s purpose and motive generally garner bipartisan support, the timing, pacing and broad implementation of the regulation are still at play.
What room for growth or evolution exists in government contracting?
The new administration’s agenda centers on bigger government and a higher level of federal spending, the details and ramifications of which will crystallize over time. On Oct. 1, the government entered fiscal 2021 under a continuing resolution that maintains spending at levels equal to the prior fiscal year. New appropriations measures may reflect the priorities of the Biden administration and the Democratic Party, specifically infrastructure, education, public health and clean energy. How the administration allocates and prioritizes future spending (including additional stimulus spending) will shape key dynamics throughout the sector.
M&A activity figures to be potent in the short term as contractors look to acquire access to agencies and contract vehicles likely to be favored by the new administration. While the national defense budget is not expected to dramatically change going forward, there could be increases at civilian agencies with missions that align more with the Biden-Harris platform. Those could include the Department of Energy, Department of Education, Environmental Protection Agency, Department of Health and Human Services, and Centers for Disease Control and Prevention, among others. Also, the possibility of higher taxes (particularly Biden’s proposal to raise the long-term capital gains rate) may be the impetus to close deals in a timely fashion.
Questions that frame the path forward:
- How will the fiscal 2021 budget be appropriated and authorized, given that many such bills have passed the House and Senate and are currently in conference?
- Which agencies align with the new administration’s vision for the country, and which will be favored as priorities?
- Will the Biden administration continue to aggressively remove Chinese threats from the defense supply chain and industrial base?
- How will the increased federal deficit and the likelihood of additional relief spending affect market opportunity for government contractors in the long term?
- Will stimulus be provided to state and local municipalities that face lower tax revenue and significant budget deficits due to pandemic lockdowns and the related economic collapse?
- Which parts of the Biden tax plan, if any, will become a reality, and would an increased capital gains rate dampen M&A activity by strategic acquirers and private equity funds?